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Contingent convertible bonds in financial networks
Giovanni Calice1, Carlo Sala2, Daniele Tantari3
1Bangor Business School, Bangor University, Bangor, LL57 2DG, UK.
Scientific Reports
|December 15, 2023
Summary
Contingent convertible bonds (CoCos) effectiveness hinges on bank network structure. In some networks, CoCos can amplify financial fragility, highlighting the need for careful network design to ensure financial stability.
Area of Science:
- Financial economics
- Network theory
- Systemic risk analysis
Background:
- Interconnectedness of financial institutions poses systemic risk.
- Contingent convertible bonds (CoCos) are designed to enhance bank capital and financial stability.
- The impact of CoCos on financial stability is complex and network-dependent.
Purpose of the Study:
- To investigate the role of CoCos in complex interbank networks.
- To analyze how network structure influences CoCos' effectiveness in promoting financial stability.
- To identify network characteristics that optimize CoCos' function.
Main Methods:
- Agent-based modeling of interbank networks.
- Analysis of system phase transitions.
- Simulation of financial shocks and CoCos triggers.
Main Results:
- The structure of the interbank network is critical for CoCos' effectiveness.
- Certain network structures can lead to increased financial fragility due to suboptimal CoCos triggers.
- Lightly interconnected networks exhibit greater robustness to moderate financial shocks compared to highly interconnected ones.
Conclusions:
- CoCos are not universally stabilizing; their impact is contingent on network topology.
- Network design is crucial for maximizing the benefits and minimizing the risks associated with CoCos.
- Less interconnected financial networks may offer a more stable environment for CoCos issuers and investors.
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